US Manufacturing Sector Weakens Further – Alea Iacta Est?
On the first trading day of the year, China’s stock market crumbled, seemingly waylaid by yet another weak manufacturing PMI report and a further slide in the yuan. On the same day, a few Fed members came out affirming that several more rate hikes would be seen in the US this year (such as SF Fed president Williams and Cleveland Fed president Loretta Mester).
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Meanwhile here is the latest update of the Atlanta Fed’s GDP Now indicator:
The GDP Now model declines to just 0.7%, once again way below the consensus range
When we last mentioned this indicator in passing, it still stood at 1.7% – and that was on December 18! Not long after that, we posted a year-end overview of US manufacturing data with updated charts from our friend Michael Pollaro. This was on December 23, but in the meantime a wealth of additional data has been released, primarily in the form of district surveys and finally the manufacturing ISM release on January 4.
Michael has provided us with a fresh set of charts, showing the evolution of the most important data points of the district surveys as an average and comparing them to the respective National ISM data. In previous updates on manufacturing data, we have mentioned that we see little reason why the trends that have been in motion since early 2015 should reverse. And indeed, they haven’t – on the contrary, they seem to be accelerating.
The most upsetting releases of late have been the Chicago ISM (which contains services as well) and the national ISM released on January 4. Both came in way below already subdued expectations, with the Chicago number falling totally out of bed, posting a headline reading of just 42.9 – well in contraction territory. In the comparison charts below, the ISM manufacturing number is still as of November, but we show the updated ISM chart further below as well
First, the average of the regional manufacturing survey headlines vs. the ISM headline index. Note that the Fed surveys oscillate around the 0 level (expansion above, contraction below), while the 50 level is the equivalent level in the ISM. As you will see, the regional surveys tend to be more volatile and have led ISM in the last recession:
The average in regional survey headlines (red) as of Dec. 2015 vs. the ISM headline (blue) as of Nov. 2015 – click to enlarge.
The next chart compares the average of the new order components of the regional surveys with ISM new orders:
Regional average of new orders (red line, to Dec. 2015) vs. ISM new orders (blue line, to Nov. 2015) – click to enlarge.
Next we look at the regional employment average vs. the ISM employment index:
Regional average employment (red line, Dec. 2015) vs. ISM employment (blue line, Nov. 2015) – click to enlarge.
The next chart compares the regional averages of new and unfilled orders as well as inventories:
Regional survey averages new orders (red line), unfilled orders (green line) and inventories (purple line) – click to enlarge.
The next chart shows the regional averages of new and unfilled orders as well as employment on the same chart. As you can see here, although these data are tracking quite closely, in downturns, unfilled orders tend to slightly lead new orders, while new orders are leading in upturns – employment tends to lag and “catch down” resp. “catch up”, once the other two series enter a strong trend.
Regional survey averages: New orders (red), unfilled orders (purple), employment (green) – click to enlarge.
The Chicago ISM (headline) is shown separately below and compared to both the national manufacturing and services ISM headline series (the latter again as of November). As noted above, the Chicago ISM is peculiar in that it reflects both manufacturing and services. This was the final release of 2015, and it was quite a disaster:
Chicago ISM headline (red, as of Dec. 2015), vs. ISM manufacturing headline (green, as of Nov. 2015) and ISM services headline (blue, as of Nov. 2015). The decline in the Chicago ISM to less than 43 points took even the bears by surprise – click to enlarge.
Lastly we take a look at the updated National ISM data, this time incorporating the manufacturing ISM release of January 4. Services ISM data are still as of November, but the new release will be published on Wednesday. It will be quite interesting what it looks like, given the weakness in the Chicago ISM headline.
National ISM headline, manufacturing (purple, as of December) and services (blue, as of November). With a reading of 48.5, the national manufacturing ISM headline has declined to a level last seen in January 2009 – at the time the stock market was entering the final leg of its GFC induced collapse, which bottomed in early March of 2009 – click to enlarge.
The next chart shows new orders according to the National ISM:
National ISM new orders – manufacturing (blue, as of Dec.), services (red, as of Nov.) – click to enlarge.
Finally, here is a comparison of National ISM new manufacturing orders (as of December) vs. the y/y change in Industrial Production (as of November):
National manufacturing ISM new orders (red) vs. y/y change rate in industrial production (blue) – click to enlarge.
Then and Now
On the longer term ISM charts above it can be seen that a similar bout of weakness in 1994/95 did not lead to a recession. Along similar lines, it has been pointed out that weak readings in late 1986 and in the summer of 1998 did not lead to recessions either – however, the latter two instances were followed by stock market crashes (one more severe than the other, but both met with major interventions by the Fed, which was even midwifing a bailout in one of these cases, namely that of LTCM). 1994 saw sizable declines in both stocks and treasury bonds, though nothing that could be termed a crash.
To this we would like to point out that these periods of weakness were all preceded by noticeable monetary policy tightening moves at a time when there still were interest rates. These small downturns are likely best seen as minor malinvestment liquidation squalls, which the Fed was able to very swiftly arrest and easily counteract by cutting interest rates, quickly igniting economic booms again. Debt levels, while already high, were a far cry from today’s monstrous debtberg.
One must also not forget that the GSEs were used in all these previous cases to reliquefy the system by vastly stepping up their purchases of mortgages from banks and the pace of mortgage securitization. Needless to say, that ship has largely sailed.
Moreover, not one of these “soft spots” was preceded by a 115% expansion in the true money supply over the prior seven years – nor were the recovery periods that ushered them in considered “weak” by any stretch of the imagination. Lastly, these periods were accompanied, resp. followed by the integration of the former communist countries into the global market economy, as well as by the economic ascendancy of China and the concomitant enormous surge in global trade. In other words, Panglossian comparisons between today’s situation and these past instances seem spurious.
We clearly live in a much different word since the near systemic collapse of 2008. Banking systems around the world continue to look vulnerable and have largely been kept afloat by central bank interventions on an unprecedented scale – something that is yet to come in some regions. There is no longer a communist bloc waiting to join the capitalist system of production, nor is there another China lying in wait – on the contrary, China is more likely to suffer a bust of its own.
European bank stocks look anything but healthy, having lost 23.5% from their secondary July 2015 peak. All of the gains predicated on Mr. Draghi’s “QE” exercise have been surrendered – click to enlarge.
There is already a burgeoning crisis in the highly capital-intensive commodity producing sector, which is bound to redound on lenders all over the world, whether they invested in bonds or made outright loans. Is is not possible to tell yet how much unsound debt will eventually have to be written off in this sector, but it is likely going to be quite a bit when all is said and done.
Corporate profit growth is weak (or nonexistent, depending on where one looks) and without profit growth, capital accumulation will remain severely impaired. Obviously, we are not referring to “per share” profits artificially boosted by buybacks and dependent on ever greater balance sheet leveraging to fund them.
Finally, it was recently revealed that government data on construction spending have been overstated for much of last year due to a “processing error”, while one of the strong spots in the economy – sub-prime lending boosted car sales – suffered a “surprise bout of weakness” in December as well, with a 5% decline in overall sales coming in well below expectations of a 1-2% decline.
Conclusion
As we already pointed out in our year-end review, the increasing weakness in manufacturing data does not guarantee an imminent recession (it has definitely become more likely though). However, those who argue that the Federal Reserve has only just begun to tighten monetary policy err: the “tapering” and cessation of QE3 was already a tightening move (we estimate roughly equivalent to 75 basis points, based on research done by Fed economists on occasion of QE2). In that sense, we have just seen the equivalent to a fourth rate hike in December, not the first.
Still, one cannot rule out that we might see a few months of fluctuation in which the data temporarily improve again. In that case, the Fed will be tempted to tighten further. This plan would undoubtedly be derailed very quickly by a sizable stock market decline, but we have no yardstick by which to determine when the lagged effects of the previous huge monetary expansion on stock prices will finally wear out.
We also don’t know what threshold in money supply growth must be crossed to bring about a major trend change in stocks – apart from suspecting that it will be higher than in previous cycles. We already have some preliminary evidence that this suspicion will likely turn out to be correct, in the form of weakening market internals. With 490 stocks in the S&P 500 going down last year and the index being held up by the outsized performance of just 10 big cap stocks, something is clearly amiss already.
As a final remark, we are entering an election year in which the incumbent will be replaced. The last two such election years were 2000 and 2008, and they were not particularly kind to the economy or risk assets. This year election-related uncertainties are likely to be higher than normal, with the current front-runners highly controversial candidates, to put it mildly.
Charts by: Atlanta Federal Reserve, Michael Pollaro, BigCharts
